Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / How the Soft Landing Changes Defensive Stock Investing
Transcript
- Lucas: So the Russell 2000 is up one point three percent over the past five days while the S&P is down one point one. The yield curve has steepened — the ten-year minus two-year spread is now twenty seven basis points. That combination is telling us something about how investors are positioning for a soft landing. Luna: And yet the VIX is at seventeen point two eight, up five percent over the same period. So there's still some anxiety in the options market. How do you square those two signals? Lucas: I think the VIX rise is mostly about the move lower in the S&P — it's not panic, it's a re-rating. The Russell action is the more interesting signal. Small caps are rate-sensitive, cyclical, domestic. When they start leading, it usually means the market is pricing in an economy that doesn't need emergency rate cuts. Luna: Speaking of that — we keep the podcast ad-free because we think these conversations are valuable enough on their own. If you get something out of them, you can support the choice at buy me a coffee dot com slash fexingo. No pressure, just an option. Lucas: Appreciate that. And it's exactly because we don't have ad constraints that we can spend ten minutes on a single yield curve number without having to chase clicks. So back to that curve — the ten-year at four point four six percent, the two-year at four point nineteen. That's a pretty normal curve by historical standards. Luna: But we got here after a long inversion. So the fact that it's normal again is itself a regime change. The question is whether that's good for the old defensive plays — utilities, consumer staples, healthcare. Lucas: Right. And the conventional wisdom is that defensives outperform when the economy is slowing. But if we're in a soft landing — growth slow but positive, inflation sticky around three percent — then maybe the traditional defensive trade needs to be re-examined. Luna: Let's look at the utilities sector. The S&P 500 Utilities Index is up about eight percent year to date as of mid-June. That's not bad, but it's lagging the S&P's double-digit gain. So investors are not piling into utilities as a recession hedge. Lucas: They're not, and I think the reason is that utilities are long-duration assets. They're sensitive to interest rates because their cash flows are far in the future. With the ten-year at four point four six, the present value of those future earnings gets compressed. So utilities are caught between being a defensive sector and being a bond proxy. Luna: Exactly. And consumer staples have a similar problem. Companies like Procter & Gamble and Coca-Cola have pricing power, but their growth is low single digits. In a soft landing where nominal GDP is still around four to five percent, you can get better growth elsewhere without taking on that much more risk. Lucas: So where do you put money if you want defense but you don't want to be long duration? One answer is the healthcare sector, specifically large-cap pharma and managed care. Those tend to have shorter duration cash flows — drug patents expire, contracts get renegotiated — and they have pricing power tied to demographics, not the economic cycle. Luna: I'd add that the Russell 2000's recent strength actually supports that view. Small caps include a lot of healthcare service companies, biotechs, and medical device makers. They're not all cyclical. Some are just small versions of the same defensive thesis. Lucas: Let's talk about the Fed angle because Kevin Warsh is now the chair and he's been described as remaking the Fed 'with a velvet glove.' The phrase is from a CNBC piece that ran over the weekend. Warsh seems to be keeping rates steady, letting the economy find its own level, rather than trying to fine-tune. Luna: That's a departure from Powell's data-dependent approach, at least rhetorically. Warsh appears to be more rules-based, more focused on the neutral rate. If that's the case, then the market has to adjust to a Fed that doesn't react to every data point. Lucas: And that adjustment is exactly what we're seeing in the yield curve. The ten-year is holding above four point four while the two-year has come down a bit. The market is pricing in a higher term premium — investors want more compensation for holding long-term bonds because they're not sure the Fed will cut even if growth slows. Luna: So the soft landing becomes a 'no landing' scenario where rates stay here. That is terrible for long-duration assets but potentially good for value stocks, small caps, and financials — sectors that benefit from a steep curve and steady growth. Lucas: Financials are a good example. Regional banks have been beaten up since the 2023 crisis, but a steep yield curve is their best environment. They borrow short, lend long. If the spread between the two-year and ten-year stays positive and wide, their net interest margins improve. Luna: The KBW Regional Banking Index is up about five percent over the last month. That's consistent with the Russell 2000 leadership. So the rotation is happening, but it's subtle — it's not a stampede out of tech, it's a gradual repositioning. Lucas: And that's actually healthy. A stampede would mean the VIX is at thirty, not seventeen. The fact that the VIX is only modestly elevated suggests this is an orderly rotation. Investors are adding exposure to small caps and value without dumping their growth positions. Luna: So for an investor listening, what's the actionable takeaway? If you've been heavy on the S&P 500 or the Nasdaq, do you shave some of that and move into a small-cap value ETF? Or into a financials ETF? Lucas: I think the answer depends on your time horizon. If you're looking at the next six to twelve months, a barbell approach makes sense. Keep your core growth holdings but add a small-cap value ETF like the iShares Russell 2000 Value ETF, which trades under i w n, and a financials ETF like the Financial Select Sector SPDR Fund, ticker X-L-F. Luna: What about duration in the bond portfolio? The ten-year at four point four six is attractive if you think rates will fall. But if Warsh keeps them steady, you could be locking in a yield that looks good now but feels low if inflation re-accelerates. Lucas: Right, so for fixed income, I'd stay short to intermediate. The two-year at four point nineteen gives you a decent yield with less duration risk. And if the curve continues to steepen, you can roll into longer maturities later. No need to reach for yield in the thirty-year at four point nine when you're not sure about the inflation path. Luna: That's a conservative approach, but it matches the uncertainty in the data. Real GDP growth was one point six percent annualized in the first quarter, up from zero point five in the fourth quarter. So the economy is accelerating, not decelerating. That supports the 'no landing' view. Lucas: Exactly. And nominal GDP is over thirty-one point eight trillion, up from thirty-one point four. That's a four point eight percent year-over-year increase. With that kind of nominal growth, corporate earnings can stay resilient even if margins compress a bit. Luna: So defensive investing in this environment isn't about hiding in utilities or staples. It's about owning assets that benefit from a steep curve and steady growth. Financials, small-cap value, and maybe some healthcare. Lucas: And it's about being aware that the old playbook — buy bonds when the economy slows, buy utilities when the Fed cuts — might not work if the Fed doesn't cut. Warsh's velvet glove could mean rates stay here for a while. Luna: That's a sobering thought for anyone who's been waiting for lower rates. But it's also an opportunity to adjust before the market fully prices it in. Lucas: And the Russell 2000's recent performance is a signal that some investors are already making that adjustment. The question is whether it's the beginning of a sustained trend or just a summer rotation. Luna: We'll have to watch the next few weeks. The VIX at seventeen point two eight leaves room for either scenario. If it stays here, the rotation continues. If it spikes, everyone runs back to tech. Lucas: Fair. But for now, the data supports the rotation. And the Fed under Warsh seems content to let the market figure it out. Luna: Which is exactly what a soft landing should look like — not a perfect landing, just one where nobody panics.